Protecting Your Personal Assets by Incorporating
One of the main reasons for incorporating a business is to protect your personal assets from legal claims against the business. Limited liability is provided to all shareholders of the corporation. In contrast, sole proprietors and partners in partnerships are personally liable for business debts.
If a business creditor sues the corporation, only the assets of the corporation may be used to satisfy successful legal claims brought against the business.
The act of incorporating, in and of itself, may not always guarantee limited liability protection. Here's why:
A corporation must be administered in accordance with the incorporation laws of the state of incorporation. For example, holding stockholder meetings (unless not required by the state), keeping minutes of meetings, documenting important economic events, such as opening a corporate bank account, and setting up a retirement.
Documenting the actions taken by the board of directors, shareholders, and corporate officers is critical in providing evidence that:
- The appropriate actions were taken
- Such actions were authorized, and
- The required formalities were, in fact, carried out.
Documents might include corporate resolutions authorizing the opening of corporate bank accounts, or minutes of shareholders' meetings recording the election of a board of directors.
Lawsuits and Tax Audits
If a savvy attorney or IRS auditor discovers that you have no evidence (no documentation) to prove that you've complied with state corporation laws, they can assert that no corporation, in fact, actually exists. This could jeopardize your limited liability protection as well as all other shareholders.
- Your personal assets could be placed at risk.
- The IRS can reclassify the business as a sole proprietorship or partnership (if you have partners) and recompute your taxes for previously filed returns. This could mean additional taxes plus interest and penalties.
The Corporate Records Book
You never know when someone will sue your business or when the IRS may decide to audit your business. This is why it's important to be prepared!
A Corporate Records Book is useful for filing important corporate documents evidencing your compliance with state corporation laws.
A Corporate Records Book can also come in handy if a request is made by an attorney or an IRS auditor to review your corporate documents. Everything will be right there in your corporate records book.
- Return to the Tax Basics for Startups Table of Contents to find related links.